Your first step is determining whether you'll pick funds entirely on your own or
rely on the help of a broker, financial planner or other adviser.

If you seek help, you will likely pay a load when you buy your fund shares. Studies
show that the commission does not buy better fund management. In general, loads compensate
the sales people who sell the funds to their clients.

If you're picking your own funds, there's no point in paying a load for
advice that you haven't gotten. On the other hand, if you go to advisers for help, don't begrudge them the commission you owe for their advice.

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If you decide to stick with no-load funds, you will slice the universe of funds you need to consider roughly in half. Once you find a no-load you like you can purchase shares directly from the fund company, or through a discount broker, which may or may not charge its own transaction fee (see the Kiplinger 25 center for our favorite no-load funds).

Study Past Results

This is arguably the trickiest part of the process, because past performance is no
guarantee of future returns. Not even the best and brightest beat the averages every year.

Focus on three- and five-year returns rather than one-year figures. A ten-year return
is even better, especially if the fund is still managed in the same way (and by the same person) now
as then and hasn't changed in some fundamental way. The longer a manager has
achieved superior results, the more confident you can be that those numbers are
meaningful.

Concentrate on the consistency of a manager's return. Even five-year results can be
exaggerated by one spectacular year.

Examine how a fund has done each year of the period you're looking at relative to
its peers or against an appropriate benchmark index (such as the
S&P 500 index for large-company funds or the Russell 2000 for small-company funds).

Incidentally, there may be times when it makes sense to invest in funds with
less-than-stellar records. For instance, aggressive-growth funds that invest in small
companies with strong earnings momentum have performed poorly over much of the past three
years. If you want to invest in such a fund because you feel those kinds of stocks are
attractively valued or because you need to round out a portfolio, be prepared to accept a
fund with poor recent results.

Who Runs the Fund?

Look at how long the most experienced manager involved in running the fund has been
associated with the enterprise. If the current manager took over the job in the past few
years, the fund's long-term record is probably meaningless. This may not disqualify a
fund from consideration, but it does serve as a yellow light.

How Risky Is It?

There is nothing inherently wrong with investing in risky funds. But if you are going
to take big risks, you ought to be compensated with big returns. What you don't want
is a fund that takes big risks but delivers just so-so returns for more than a year or
two.

The Costs of Owning

All funds charge investors for the cost of management, sending out prospectuses and
shareholder reports, legal services, accounting and other administrative matters. These
costs are expressed by the fund's expense
ratio. An expense ratio of 1.00 means a fund extracts $1 a year for every $100
invested. (Performance results, incidentally, include these ongoing expenses.)

It's always better to invest in a less costly fund. Expenses vary among different
types of funds, so it's important to view expenses in the context of a fund's
category. See Sales Loads and Other Charges for more information.

Is Size a Problem?

All things being equal, it is easier to manage a modest amount of money than a huge
amount. Managers who invest in large, easily traded U.S. stocks or
government bonds can hold many billions in assets without unduly hampering results. But
funds specializing in small-company stocks or junk bonds might be overwhelmed by even $1
billion in assets. With small-company funds in particular, think twice about any fund with
assets greater than $1 billion.

Study the Style

Once you've identified consistent, high-performance, low-cost funds with
acceptable levels of risk, learn how the managers run them. The fund's style will help
you understand which market conditions are conducive to great returns and which are likely
to hurt. See Focus on Categories for details on the different kinds of funds.

You'll smooth the volatility of your overall portfolio if you choose funds from a variety
of investment objectives and, in the case of stock funds, a cross section of investment styles.
Request both a prospectus and a shareholder report. The prospectus contains information
about the fund's objectives, its strategy for achieving those objectives, and its
risks.

A shareholder report will list a fund's recent holdings. Also check management's letter to shareholders. It
sometimes contains useful information about the manager's strategy or an assessment
of his or her recent performance.

What's the Yield?

In general, the higher the
12-month yield (that is, income distributed to shareholders the previous 12 months), the
riskier the fund. Because bond-fund yields tend to be modest, low expenses are even more
important.

Read the Prospectus

If a fund catches your eye, call the fund company and ask for its prospectus. Read the section on the fund's investment objectives and policies, which tells you what types of securities it may invest in. Also
be sure to read the sections that describe the fund's risks and expenses to verify your research.

A fund's annual and semiannual reports will give a snapshot of the fund's recent holdings. Also look at which industry sectors
a stock fund is emphasizing. If a fund says it invests in blue-chip stocks and
you don't recognize any of the names of the stocks in the annual report, that should
set off an alarm.